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E-MailEric M. Rosof is a partner focusing on financing for corporate transactions at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton memorandum by Mr. Rosof, Joshua A. Feltman, Gregory E. Pessin, and Michael S. Benn.
Last year’s robust acquisition financing market helped drive the headline-grabbing deals and record volume of M&A in 2015. At the same time, credit markets were volatile in 2015 and appeared to have shifted fundamentally as the year went on—and with them, the types of deals that can get done and the available methods of financing them. U.S. and European regulation of financial institutions, monetary policy, corporate debt levels and economic growth prospects have coalesced to create a more challenging acquisition financing market than we’ve seen in many years. As a result, 2016 is likely to be a year that demands creativity from corporate deal-makers, and where financing costs, availability and timing have significant influence over the type, shape and success of corporate deal-making.
Investment Grade Acquisition Financing—2015
Investment grade acquisition financing activity showed continued strength in 2015, with bridge commitments for “mega mergers” leading the way. In March, Morgan Stanley and The Bank of Tokyo-Mitsubishi UFJ provided an $18 billion bridge commitment to backstop AbbVie Inc.’s acquisition of Pharmacyclics. In November, AB InBev announced the largest corporate loan on record when it obtained commitments for $75 billion in connection with its acquisition of SABMiller. Continuing the trend to issue permanent financing well in advance of closing a transaction, notwithstanding the carrying costs, AB InBev recently priced $46 billion in bonds to support its transaction.
In prior credit cycles, deterioration in acquisition financing markets has tended to creep up the ratings scale, with bank risk management during a persistent downturn resulting in changes to pricing, terms, and permanent financing take-out methods for not only high-yield but also cross-over and low investment grade acquirors. Stay tuned. Moreover, as equity and credit investors become increasingly concerned with business risks attendant to higher corporate leverage, it may become less desirable to use cash to finance M&A activity. Combined with lower equity valuations, these dynamics could negatively affect deal activity, particularly for acquirors at the lower end of the investment grade range, many of whom have added significant leverage to their balance sheet over the past couple of years.
Leveraged Acquisition Financing—2015
In the high yield financing market, challenging conditions in the first half of 2015 worsened after August, and weakness previously limited to certain sectors (oil and gas, mining and retail) could be seen among lower-rated borrowers generally. High-yield bank loan and bond mutual funds and ETFs experienced substantial outflows during the year, which accelerated at year-end.
Critically, for the first time since 2008, banks faced the prospect of taking significant losses on a large (by some accounts reaching as high as $15 billion) backlog of leveraged buyout loans. Garnering headlines, a $5.5 billion bank and bond deal to finance Carlyle’s takeover of Symantec Corp.’s data-storage business, Veritas, was pulled in November, leaving the commitments on the books of the lead banks. Other deals that did get done were restructured, and many priced well outside their anticipated range. Accordingly, by the end of the year, financing sources began insisting on a broader toolkit for exiting their bridge commitments, including expanding the types of markets they could require borrowers to use to permanently refinance a commitment as well as wider rights to “flex” pricing, structure and other terms. Not surprisingly, upward pricing flexes outnumbered downward pricing flexes 3:1 in fourth-quarter syndications.
Approaching 2016
Against this landscape, here are some thoughts on obtaining and structuring acquisition financing in
- Explore financing options early in the transaction process. Steady and robust financing markets over the last few years have allowed for great outcomes in short time-frames; avoid being lulled into complacency—planning ahead is now likely to be rewarded.
- Consider approaching multiple sources of financing before finalizing a plan. A strong working relationship with a lead bank that knows the business may, in ordinary circumstances, be the best source for financing. However, in a choppy credit market, financial institutions may have shifting internal priorities that could impede obtaining the best financing result for a particular deal at a particular time, and price and terms discovery will be more opaque. As a result, involving a second (and in some cases more) financing source earlier in the process, and keeping them actively engaged and competitive until the financing commitments are completed and the deal is signed, may be appropriate.
- Cultivate a broader array of financing relationships. As traditional (i.e., regulated) lenders continue to be somewhat constrained with respect to highly levered transactions, the importance of alternative financing sources, such as “non-bank” banks (i.e., investment banks that are not depository institutions), asset managers, sovereign wealth funds and pension funds has increased. Cultivating relationships with these institutions prior to pursuing specific transactions may be a worthwhile investment and facilitate the competitive dynamic referred to above.
- Evaluate deal structures that minimize financing requirements. Preserving legacy debt—for example by avoiding change of control puts or defaults—can significantly alter the amount of new financing needed to complete a deal, thereby reducing challenges of obtaining upfront financing commitments, reducing the depth of the market needed when funding the deal, and perhaps keeping in place low-cost and covenant-lite debt raised in better times. As a result, the benefits of a hard look at existing capital structures and transaction structure alternatives with financial and legal advisors may be substantial.
- Consider the level of financing certainty as a fundamental part of overall deal negotiations. “Certain funds” merger agreements—with no buyer financing condition or a financing out only where banks fail to fund on their commitments (in which case a buyer may pay a substantial termination fee)—are the unquestioned paradigm for debt-financed deal-making in the United States today. But this convention developed at a time characterized by highly competitive credit markets and readily available, low-cost bridge commitments with relatively tight “flex” provisions. Substantial M&A deals have been struck on the basis of best efforts financing, with hybrid structures where no commitment was obtained and an acquirer was obligated to complete a transaction only if financing that met negotiated standards were obtained, and otherwise departing from the certain funds paradigm. Financing termination fees could become more widespread, and could shrink. Consider the specifics of each deal with an open mind.
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In rapidly changing financial markets, where conditions, terms and pricing available to support deals may change on a weekly basis, careful and creative construction of the financing plan early in a transaction process will increase the likelihood of success and allow acquirors to seize on optimal market conditions when they arise. Advance planning for deals with experienced and thoughtful legal and financial advisors will be increasingly important in meeting the challenges of the year ahead.
